The Cost of a U.S. Debt Downgrade

For a few months now, economists and econo-pundits have been warning that a U.S. downgrade would be very harmful. It will cost investors billions of dollars and the U.S. will face higher borrowing costs, they say. Now we've got a new report from Standard and Poor's -- the rating agency that started all the talk when it revised its U.S. debt outlook to negative in April -- that details the pain a downgrade would cause.

Peter Schroeder at the Hill reports on S&P's research. First, the cost:

By effectively comparing the costs of a CDS for American debt with the cost for insuring against the debt of other nations of varying creditworthiness, Standard & Poor's painted a rough picture of what a lower-rated America would mean for investors -- and it's not pretty.

Standard & Poor's said in its report that investors could suffer losses that "could easily range from $50 to $100 billion" as prices for existing Treasury bonds could fall by up to 6 percent.

And let's be clear who these investors are. Many of them are foreign. But Americans' exposure to Treasuries is also very, very great. Lots of conservative bond funds hold them, so pensions and other retirement funds would be hit.

Taxpayers would also be hurt by a downgrade. The report also details how debt costs would rise:

If Standard & Poor's lowered the nation's credit rating to double-A, the interest rate on Treasury bonds would increase by roughly 23.2 basis points, or 0.232 percent. If it were to fall all the way to single-A, the cost of borrowing would climb by about 37.5 basis points.

That change might seem paltry, but when dealing with a deficit of over $1 trillion, those small boosts can add up. By the firm's math, that shift would mean an additional $2.32 to $3.75 billion a year just in additional interest.

Put another way, the deficit would be even harder to pay off, because U.S. would have to pay more for its future debt issuance. In other words, taxes would have to rise by more or spending would have to be cut even deeper.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation.